COURSEWORK

The recent volatility on world currency markets of quotations for major currencies has created global concern about the possibility of "international currency wars". These fears stem from the establishment of excess liquidity by major developed countries, which is a serious problem for emerging markets, because it stimulates a significant inflow of speculative capital to their markets.

Danger of the weakening dollar

On 3 November, the US Federal Reserve System announced a new programme to repurchase assets of $600 billion (the so-called "quantitative easing" programme). This is the monthly repayment of long-term treasury bonds worth $75 billion.

In parallel, Russia proposed the creation of a system of risk insurance at the International Monetary Fund (IMF), in which the insurers could be states or market participants. This system could be an alternative to the global network of financial security proposed by South Korea, which is designed to provide quick access to financial resources in the event of a crisis or its symptoms. In particular, Seoul proposed schemes for credit lines to countries without making demands of their economic policy.

The problems on foreign exchange markets were one of the main items on the agenda of the G20 summit held in Seoul on 11 November. China's Ministry of Commerce said in a report that it was the progressive weakness of the dollar that had generated "currency wars" in the world economy and created additional threats to exporting countries.

"The continued depreciation of the dollar recently compelled a group of countries, including Japan, South Korea and Thailand, to intervene on foreign exchanges, sharpening the 'currency wars'," says the document. "In the medium term, the dollar's exchange rate will probably continue to fall, thus boosting competition between major currencies and increasing risks to companies." The report also expressed concern that "the slow growth observed in the world economy, as well as the adoption by leading industrial countries of macroeconomic policies based on their own interests, will increase protectionism in world trade".

On the one hand, the US accuses China of artificially lowering the exchange rate of the yuan for its exports. On the other hand, China indicates that the US policy of cheap money and inflating liquidity leads to a fall in the rate of the dollar and the generation of huge cash flows around the world, undermining the stability of the global financial system.

World Bank President Robert Zoellick also said that the exchange rate problems, if not addressed properly, may lead to increased protectionism. To counterbalance them, he called on the G20 to focus on supporting economic growth, since foreign currency adjustments would take place more easily in a period of global increase.

Following the G20 summit in Seoul, a joint agreement was signed aimed at reviving world trade, and countries agreed to adopt certain measures to ensure the world's potential for economic growth . One such measure is the completion of the Doha round of global trade liberalization talks under the WTO next year.

In addition, summit participants agreed to oppose protectionism and trade barriers. Also according to the communiqu?, members of a working group intend to strengthen the global financial and banking system by increasing banking liquidity reserves and improving their quality as part of the Basel-3 reform.

Exchange rate policy in Azerbaijan

Contrary to the depreciation of their national currencies by other countries, the Central Bank of Azerbaijan has, since 28 October, implemented a policy of strengthening the exchange rate of the manat against the dollar. Explaining the situation, the Central Bank noted that the depreciation of the dollar on the world's currency markets has an effect on the setting of the exchange rate inside the country. However, on the domestic market, supply and demand are the main factors affecting the establishment of the rate for the manat-dollar pairing. The Central Bank intends to maintain a stable national currency until the end of 2010.

In 2011, the CBA will follow the same policies and conduct an exchange rate policy which responds to the situation inside the country and the global environment. "In conducting our exchange rate policy, the main focus will be on inflation and the country's competitiveness," said the CBA.

Representatives of the Central Bank believe that when studying the effect of the exchange rate on inflation, attention should be given to changes in the nominal effective exchange rate, i.e. multilateral rather than bilateral exchange rates. In nine months of 2010, the nominal effective exchange rate for the non-oil sector grew by 3 per cent. This, in turn, limited the import of inflation into Azerbaijan and made it possible to offset to some extent the negative effects of accelerating inflation in partner countries and rising prices for cereal crops.

Many countries have now begun to actively promote exports and economic growth by reducing the value of their national currency. However, the CBA considers it incorrect to promote these aims only via exchange rate policy - you can only make a contribution to these processes this way. The exchange rate policy pursued by the CBA in accordance with the structure of the economy aims to expand exports and accelerate economic growth, i.e. it recognises the need to protect the country's competitiveness. As a result, the real effective exchange rate of the manat in non-oil exports, most of which go to Turkey, Russia, Ukraine, Georgia, Iran, Kazakhstan and Belarus, fell by 1.1 per cent.

Even earlier, CBA chief Elman Rustamov noted that on the foreign exchange market, the supply of foreign currency far exceeds demand today. "Given this fact, the Central Bank is carrying out sterilization in order to strengthen the manat, and the national currency is more likely to strengthen rather than become cheaper on the market," said the country's chief banker. He added that changes in the rate will depend on the overall macroeconomic situation in the country, but there can be no talk of devaluation, even though, perhaps, such a policy would impact on inflation and the oversupply of foreign currencies on foreign exchange markets. Note that in the first nine months, the Central Bank bought about $1 billion on the foreign exchange market and by the end of the year this figure could double. Rustamov does not deny that there is still a risk of inflation in Azerbaijan exceeding the projected level of 5 per cent in 2011. These arguments have been backed by excessive ingress of inflation into the country caused by rising prices for grain and related products on the world market; the effect is already discernible.

However, it should be recognized that the Central Bank's actions and the measures it took during the deepening global financial crisis, reassure us that the national currency's exchange rate will remain stable, even during the start of so-called "currency wars". This is supported by the fact that during the global financial crisis, while many countries faced devaluation and defaults, Azerbaijan maintained a stable exchange rate for the manat.

Diversification of the economy - a guarantee of stability

Meanwhile, experts in the banking sector are also confident that having once proved its resistance to world cataclysms, Azerbaijan will be able to protect itself this time too.

According to banking specialist Calal Qasimov, Azerbaijan is unlikely to participate in "currency wars", although given that the manat is pegged to the basket of freely convertible currencies, particularly the dollar, it might be affected. So, like many other experts he agrees that if the danger on the world markets grows further, it will affect everyone. "Any war is always more harmful than useful," said the expert. "Today, Azerbaijan, having enough resources, is able to calculate the potential damage from any effect of the "currency wars" on our economy in general and, depending on that calculation, take any necessary action. Given its large gold and currency reserves, the Central Bank may again resort to intervention in order to avoid sharp jumps in the rate. The most important thing is to avoid volatility and force majeure situations on global currency markets. As for the national currency becoming more expensive, that is a normal process."

Another banking expert, Rasul Calilov, considers the current situation on the global currency market to be natural. "Everyone is trying to stimulate their economies by increasing exports and, therefore, they are artificially devaluing their currencies in order to lower the cost of domestic production. And today, the US, EU and Japan are interested in a weak dollar, euro and yen, respectively, to stimulate their production and exports, and to reduce unemployment," he said.

Meanwhile, economist Ali Masimli says that it is very important today to pursue a policy of ensuring a weighted exchange rate for the manat, in particular, to maintain its competitiveness against the currencies of Azerbaijan's trading partners. "Given that oil prices continue to rise, which in turn leads to appreciation of the national currencies of petroleum exporters, including Azerbaijan, a strengthening of the manat against the dollar is inevitable in the short term. But this does not mean that this process can be allowed to get out of control, as that would cause great harm to Azerbaijan's economy. Therefore, the CBA has to regulate this process and avoid excessive appreciation of the manat," says the expert. According to Masimli, it is likely that the government will conduct just such a policy because if the manat becomes much more expensive and the dollar becomes too cheap, this will stimulate imports, i.e. increase imports of foreign goods into the country. Exports, in turn, may suffer. "Thus it is necessary to conduct a competitive exchange rate policy to ensure that the manat does not rise unduly, as this may restrict local production in some areas, and this will lead either to higher prices for some goods and services or to a situation in which local production will not be able to compete with cheap imports and will be forced to leave the market," said Masimli.

For peace on the foreign exchange market

As we have already mentioned, war on the foreign exchange markets is of no benefit to all parties involved and, therefore, many countries are willing to take measures to counter this threat. For example, European Commission President Jose Manuel Barroso proposed that the global economy should make the real sector a general reference point. He also invited the leaders of the world's leading countries to encourage states to establish a more market-based monetary system that would reflect economic fundamentals. Barroso also urged them to refrain from competitive devaluations.

By the way, at the G20 summit in Seoul, French Finance Minister Christine Lagarde also raised the issue of reforming the international monetary system in order to ensure sustainable growth in the global economy. The current instability and volatility indicate that the system needs reform, the minister said. At the same time, she said, reform does not simply mean replacing one currency with another.

Agreement to give up "currency wars" was reached at the meeting of finance ministers and G20 Central Bank chiefs in the South Korean city of Gyeongju.

The Azerbaijani government's projections for the next four years also confirm its desire to maintain the country's stability by accelerating the development of the non-oil sector. The government predicts that by 2014, the share of the oil sector in GDP will fall to 38 per cent against 47 per cent in 2009; this will be achieved by "successful diversification of the economy", said Minister of Economic Development Sahin Mustafayev earlier. The share of the non-oil sector in GDP will increase from 45 to 53 per cent, while the non-oil GDP growth rate is projected to be 7.2 per cent for 2011 and an average of 8 per cent for the next three years.

According to the minister, to ensure this growth according to the Azerbaijani president's instruction to develop the private sector, it is planned to improve the legislative framework and state regulatory system, improve the business climate, expand state support, especially for small and medium-sized enterprises, improve financial, infrastructural, advisory and information management, attract foreign and local investment, modern technology and management expertise and support the production of high quality, competitive products.

As can be seen from the Azerbaijani government's projections, for 2011 and the next three years, it is planned to significantly increase the competitiveness of the country's economy by diversifying the Azerbaijani economy. In the first nine months of this year, growth in the non-oil sector exceeded not only the growth in the oil sector, but also in the entire gross domestic product. During this period, GDP growth was 4.1 per cent, while growth in the non-oil sector was 5.2 per cent.

In other words, even if war breaks out on the currency markets, Azerbaijan will be able to maintain "neutrality" and protect itself against the consequences of financial battles.